There are a couple of ways that a government can tackle a mounting debt problem.
If the debt itself is reasonable, and the economic conditions are stable, the method with the least repercussions is through growth. If the economy is expanding rapidly enough, the debt of the country should be very manageable. Austerity measures or cutting spending is another solution although, once again, it assumes that the debt is reasonable to start with.
But what happens when the debt is out of proportion relative to the gross domestic product of a country? The quick and dirty way of getting out of it is to simply default. The main problem with this solution is that the consequences are bound to be extremely damaging. Think Lehman's and multiply the effect a thousand times! A softer version of this is to restructure the debt by means of applying a haircut or just simply extending the maturity. That is, for example, what the markets are anticipating for Greece.
Another method is for a country to try to inflate itself out of the debt spiral. The idea is that by stimulating the economy, prices will begin to rise high enough to depreciate the value of the outstanding debt. The real value of that debt has actually changed since the lender is getting paid less in real terms than what was lent in the first place. The major drawback with this approach is that the impact of inflation goes beyond debt and is therefore bound to be politically unpopular.
A related method is the devaluation of the currency, a tool that is unfortunately unavailable to the peripheral nations in Europe who need it most. By devaluing the currency, foreign lenders get paid less in real terms, so technically it becomes cheaper for the borrow to service the debt. This is a very attractive proposition for the U.S. where the large bulk of debt is in the hands of foreign owners. It would explain why the Fed is in no hurry to tighten rates like the rest of the world is doing. Depreciation has its drawbacks too. It could trigger inflation by boosting demand for exports and spiking the price of imports.
Although the examples show that there are several ways a country can tackle its debt problems, it doesn't mean that they have access to all these methods. Eurozone countries are a case in point: By joining the Euro they gave up the very monetary tools that would have provided them with greater flexibility. Without these tools, they can't inflate themselves out of the debt and nor can they depreciate the currency. This leaves them with two possible solutions: hard core austerity (which doesn't seem to be working) and restructuring. It looks increasingly likely that some form of restructuring will eventually have to take place.
If the debt itself is reasonable, and the economic conditions are stable, the method with the least repercussions is through growth. If the economy is expanding rapidly enough, the debt of the country should be very manageable. Austerity measures or cutting spending is another solution although, once again, it assumes that the debt is reasonable to start with.
But what happens when the debt is out of proportion relative to the gross domestic product of a country? The quick and dirty way of getting out of it is to simply default. The main problem with this solution is that the consequences are bound to be extremely damaging. Think Lehman's and multiply the effect a thousand times! A softer version of this is to restructure the debt by means of applying a haircut or just simply extending the maturity. That is, for example, what the markets are anticipating for Greece.
Another method is for a country to try to inflate itself out of the debt spiral. The idea is that by stimulating the economy, prices will begin to rise high enough to depreciate the value of the outstanding debt. The real value of that debt has actually changed since the lender is getting paid less in real terms than what was lent in the first place. The major drawback with this approach is that the impact of inflation goes beyond debt and is therefore bound to be politically unpopular.
A related method is the devaluation of the currency, a tool that is unfortunately unavailable to the peripheral nations in Europe who need it most. By devaluing the currency, foreign lenders get paid less in real terms, so technically it becomes cheaper for the borrow to service the debt. This is a very attractive proposition for the U.S. where the large bulk of debt is in the hands of foreign owners. It would explain why the Fed is in no hurry to tighten rates like the rest of the world is doing. Depreciation has its drawbacks too. It could trigger inflation by boosting demand for exports and spiking the price of imports.
Although the examples show that there are several ways a country can tackle its debt problems, it doesn't mean that they have access to all these methods. Eurozone countries are a case in point: By joining the Euro they gave up the very monetary tools that would have provided them with greater flexibility. Without these tools, they can't inflate themselves out of the debt and nor can they depreciate the currency. This leaves them with two possible solutions: hard core austerity (which doesn't seem to be working) and restructuring. It looks increasingly likely that some form of restructuring will eventually have to take place.
